Natural resources and capital: a green perspective

Some of the hypothesis made in Economics when modeling a given phenomenon hide implicit assumptions about the relationship between the economic process and the environment. We will focus our attention on two examples about the assumption of substitutability between capital and natural resources: the Solow-Stiglitz Cobb-Douglas production function and the Adjusted Net Savings (ANS) Indicator  presented in this blog two weeks ago.

• The Cobb-Douglas production function is commonly used in Economics thanks to its “nice” properties (constant returns to scale, Inada conditions and many other technical details). The so-called Solow-Stiglitz Cobb-Douglas production function has the following form: Q=K^a1R^a2L^a3 . Where Q= Output, K = Capital, R = Natural Resources, L = Labor, and a1+a2+a3=1. This could be seen as a nice way to include natural resources in the production function. Unfortunately there is a big drawback:  the extreme assumption of substitutability between capital and natural resources. Indeed, it is straightforward to show that, assuming a given quantity of labor L0, any level of production Q0 can be attained if R^a2 =Q0/(K^a1L0^a3 ). In other words: R can be as small as we wish provided K is big enough. This is not obviously true since capital needs resources and the increase in capital will accelerate the depletion of resources. As Daly points out, this “calls for making a cake with only the cook and the kitchen”.
• The second example is taken from a post that I wrote two weeks ago: on it, the ANS indicator was proposed as a comprehensive indicator of ecological, economic and social progress. This indicator takes into account  investments in human capital, adjusted net savings and depletion of natural resources and damage caused by pollution. Once again, the problem is the assumption on substitutability among components: large increases in depletion of natural resources can be compensated by larger investments on human capital or increases in national saving. The future of next generations can be severly put into risk while the indicator says that “society is doing fine”.

Of course, one can say that the Solow-Stiglitz production function is used to deal with subjects not related with sustainability (namely explaining the reasons behind economic growth) or that it is better to include environmental damages in an indicator of social performance (even assuming substitutability with other factors) than nothing. I cannot completely agree with this kind of arguments: economic growth is a key economic phenomenon which, like all economic phenomena, is embedded in a general frame -Planet Earth- and that is subjected to physic laws. We shouldn’t forget this (evident?) truth. From my point of view, these facts show a dangerous mistake in the economic mentality when analyzing the relation between economic activity and the environment. The indicators and the models could change their assumptions and consider complementarity between capital and natural resources instead of substitutability. Another option when dealing with measures and indicators, is the adoption of ecological thresholds that cannot be exceeded when measuring environmental damages. Finally, in academia, I would propose to rescue from oblivion one of the greatest figures of economic thought: Nicholas Georgescu-Roegen as the best way to relance a rigorous and stimulating green economic debate.